What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s amount of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Premier Investments (ASX:PMV) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Premier Investments, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.13 = AU$216m ÷ (AU$2.2b – AU$515m) (Based on the trailing twelve months to July 2020).
Therefore, Premier Investments has an ROCE of 13%. In isolation, that’s a pretty standard return but against the Specialty Retail industry average of 16%, it’s not as good.
Above you can see how the current ROCE for Premier Investments compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Premier Investments.
So How Is Premier Investments’ ROCE Trending?
Premier Investments is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 76% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It’s worth looking deeper into this though because while it’s great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 23% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Key Takeaway
In summary, we’re delighted to see that Premier Investments has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 99% return over the last five years. In light of that, we think it’s worth looking further into this stock because if Premier Investments can keep these trends up, it could have a bright future ahead.
On a final note, we’ve found 2 warning signs for Premier Investments that we think you should be aware of.
While Premier Investments isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.